SEC’s White Vows New Safeguards Following Nasdaq Failure

By Dave Michaels -
Aug 23, 2013

U.S. Securities and Exchange
Commission Chairman Mary Jo White, responding after system
errors caused a three-hour halt on the Nasdaq Stock Market, said
she will push to adopt proposed automated-trading rules.

The failure that affected Nasdaq’s system for reporting
quotes and prices bolsters the case to pass a proposal issued in
March, White said in a statement. Advancing it will require the
regulator to face down opposition by exchanges, which have
pushed the SEC to limit the scope of the rule, including how
much information about glitches they must be provide.

“I will work to advance rules that the commission proposed
earlier this year regarding new standards for the trading and
other systems that are central to the integrity of our
markets,” White said.

White, who told Congress earlier this year that she would
scrutinize market stability efforts, also said yesterday she
would “convene a meeting of the leaders of the exchanges and
other major market participants to accelerate ongoing efforts to
further strengthen our markets.”

Nasdaq said in a statement yesterday that the failure
stemmed from “a connectivity issue between an exchange
participant” and the system for disseminating quotes and
prices, called a securities information processor, or SIP.

Testing Requirements

The SEC’s proposal, Regulation SCI, would require self-regulatory organizations such as exchanges, clearing firms and
SIPs to adopt policies to prevent failures, stress test their
systems to ensure trading continues through a disruption, and
report glitches to regulators. The rule also would cover
exchange competitors known as alternative trading systems, or
dark pools. The SEC has said 10 dark pools are large enough to
be subject to the regulation, based on data from 2012.

The rule would replace a voluntary program created after
the stock market crash of 1987. Requiring compliance through a
rule that would authorize the SEC to respond to compliance
failures with penalties such as fines and sanctions.

“Reg SCI basically gives the SEC the ability to ding any
exchange for any problem,” said James J. Angel, a finance
professor at Georgetown University’s McDonough School of
Business.

SEC Commissioner Michael Piwowar, who joined the agency
last week, today advised caution on advancing the regulation. He
said in a that while recent market disruptions, including errant
options trades involving Goldman Sachs Group Inc., demand
attention, the commission should should ensure that any new rule
fits the facts learned from recent failures.

Challenging ‘Assumptions’

“Regulation SCI may or may not have contemplated what
ultimately caused these disruptions,” Piwowar, a Republican
economist, said in a phone interview. “Therefore, we should re-evaluate the assumptions underlying the Regulation SCI proposal
before moving forward with further rulemaking.”

Exchanges said last month the SEC “significantly
underestimated” the cost of compliance with the proposal. The
agency calculated initial costs could be as much as $242 million
for organizations subject to the regulation, with another $191
million in annual costs.

The exchanges also want the SEC to limit the rule to
systems that support trading, clearance, settlement, order
routing and market data in real time. They also say the
commission should adopt a “materiality threshold” for
reporting compliance failures or system intrusions to the
regulator.

SEC’s Authority

Some of the rule’s critics have questioned whether the
SEC’s oversight authority allows it to impose technology
standards on self-regulatory bodies, which enjoy a special
status under federal law.

“Striking to me has been the kind of collective resistance
by the self-regulatory organizations to much of what is in the
release,” said Andrew M. Klein, a partner at Schiff Hardin LLP
and former director of trading and markets at the SEC.

The SEC said it accelerated the writing of Regulation SCI
after automated trading errors drove more than $450 million in
losses for Knight Capital Group Inc. last year, leading to its
sale to Getco LLC.